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Excluding Over-the-Counter Drug Reimbursements

Make medical reimbursements less of a headache.

evenue ruling 2003-102 held that an employee’s
receipt of a reimbursement from an employer-sponsored health
flexible spending arrangement (health FSA) under a cafeteria
plan, health reimbursement arrangement or other employer
health plan for over-the-counter (OTC) drugs is excludible
from gross income under IRC section 105(b); however, amounts
an employee pays for dietary supplements are not
reimbursable or excludible, nor can the individual deduct
such costs as section 213 medical expenses. CPAs should
familiarize themselves with this ruling to educate eligible
clients.

FACTS N sponsored a
health FSA that reimburses participating employees for
medical care costs not covered by other insurance.
Participating employee A purchased an antacid, an allergy
medicine, a pain reliever and a cold medicine from a
pharmacy without a prescription to treat personal injuries
or sickness and also bought dietary supplements without a
prescription to maintain general health and submitted
substantiated claims for these expenses to N’s plan.

ANALYSIS Generally
under section 105(b), an individual excludes from income
amounts reimbursed for medical care costs. Under regulations
section 1.213-1(e)(1)(ii), an expenditure for an
individual’s general health is not a medical care
expenditure. Further, the costs of “medicines and drugs”
(defined by regulations section 1.213-1(e)(2) as
“items…legally procured and generally accepted as falling
within the category of medicine and drugs”) are medical care
expenditures, but the costs of toiletries, cosmetics and
sundry items are not; see regulations section 1.213-1(e)(2).

The IRS had stated in revenue ruling 2003-58 that an
individual cannot deduct under section 213 amounts paid for
OTC medicines or drugs. In revenue ruling 2003-102, the
service ruled that A’s expenditures to purchase the OTC
remedies were medical care expenditures; A’s health FSA
reimbursement for those costs was excludible from gross
income under section 105(b), even though the cost would not
have been deductible under section 213(a). Because the
dietary supplements were beneficial only to A’s general
health, their cost was neither reimbursable nor excludible
under section 105(b).

RAMIFICATIONS Revenue
ruling 2003-102 clarifies that the exclusion for
reimbursements of employees’ health expenses is broader than
the section 213 itemized deduction for medical expenses.
Employer reimbursements of employee health expenses for OTC
drugs are treated the same as other excludible employer
reimbursements of employee health expenses. The service’s
position should result in savings for individuals in
employer plans who have chronic health problems and
constantly take OTC medicines. An employee generally
forfeits amounts contributed to an FSA that have not been
expended by the plan yearend. Now, an employee could use
those funds to replenish his or her medicine cabinet through
the purchase of OTC medications. (For background see “FSAs
and Over-the-Counter Medications,” page 81.)

For
more information see the Tax Clinic, edited by David
Kautter, in the January 2004 issue of Tax The Adviser.

—Lesli Laffie, editor The Tax Adviser

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